Profits were markedly higher than last year, with net income soaring to $2.9 billion from just $256 million.
Online sales and subscription services revenue continued to rise, with physical store sales (predominantly comprising Whole Foods) has remained broadly flat. The main driver of the business remains the company’s cloud-computing division, Amazon Web Services (AWS), which continues to drive overall profit growth.
Amazon warns Q4 sales growth could be lowest in three years
Although known for providing conservative guidance figures the overshadowing factor of Amazon’s latest results was the warning that growth is expected to significantly slow in the final quarter of 2018. Having delivered almost 30% growth in the third quarter and an average of 28% over the last eight Amazon is expecting year-on-year growth of between 10% to 20% to between $66.5 billion to $72.5 billion, short of analyst expectations for growth to slow to 22%. If Amazon delivered the midpoint range of guided growth then it would be the slowest on record for three years.
Operating profit in the fourth quarter of the year is expected to be between $2.1 billion to $3.6 billion. The bottom of that range would match last year’s figure but the top-end would still miss the $3.7 billion delivered in the third quarter.
There are some significant cost increases occurring in the fourth quarter which Amazon says has been incorporated into its guidance, such as higher shipping costs (up 22% in the third quarter to $6.6 billion). The most notable rise, however, is the pay rise it is giving to US and UK workers in November and December this year that will see a reported 400,000 employees pushed up to a new minimum wage equivalent to $15 per hour. Additionally, changes to how it accounts revenue from its Prime subscription service means $300 million worth of income and revenue will be knocked off in the final three months of the year. However, there is upside in the last quarter too: Divali, having fallen in the third quarter of 2017, will fall into Amazon’s fourth quarter in 2018.
Amazon’s international business fails to keep up with North America
Amazon has managed to largely maintain stellar growth in its core North American e-commerce market but has seen growth elsewhere plunge by more than half. Net sales in North America, which accounts for over 60% of its overall revenue, was up 35% in the third quarter to $34.3 billion to match the figure reported a year earlier while international net sales grew by just 13% to $15.5 billion compared to 29% a year earlier.
International net sales account for just under one-quarter of Amazon’s total and the significance of the slowdown is exacerbated by the fact the unit is still producing losses, even if its negative margin has shown consistent improvement over the last 12 months. Plus, the sheer size of Amazon in North America relative to other geographies means the international division should be outpacing that of its core market: Amazon held 46% of the US e-commerce market in 2017 compared to just 24% back in 2012 while Walmart, for example, has seen its share rise to just 4.3% from 2.9% in the same timeframe, according to Euromonitor. By the end of 2018, taking data from eMarketer, Amazon will hold 49.1% of the market to be way ahead of any rivals, with second-place eBay estimated to hold just 6.6%, Apple 3.9%, Walmart 3.7% and Home Depot 1.5%.
Read more: eBay sues Amazon over ‘poached sellers’ campaign
Some analysts said the main factor behind Amazon missing top-line expectations in the third quarter was down to a $1 billion shortfall from the international division, despite its annual Prime Day sale falling at the very start of the quarter. Earlier this year it said it had over 100 million Prime subscribers around the world as numbers continued to rise despite a 20% hike in prices.
Amazon Web Services provides over half of profits
The cloud-computing division continues to be the profit engine of the business providing the cash generation it needs to reinvest. AWS contributed $2.1 billion of the company’s overall operating profit of $3.7 billion, accounting for over half the total. Surging revenue was complimented by the division achieving a margin of over 30% for the first time (from 25.5% a year earlier and 26.9% in the second quarter of 2018) to deliver a 77% rise in quarterly profit.
Meanwhile, Microsoft’s quarterly results showed Azure Cloud saw revenue jump 76%, while Google said it believed its own cloud platform was 'the fastest-growing major public cloud provider in the world'.
Read more: Microsoft’s Q3 revenue and earnings beat forecasts
Amazon advertising business unnerves Google and Facebook
The online advertising market has long been a digital duopoly shared between Google, which owns the lion’s share of the market through its dominance in search, and Facebook, which has tapped-in to the huge array of personal data it has on its users and opened a door for advertisers to reach people as they endlessly scroll through their social media feeds.
Figures from eMarketer suggest Google has a 37% share of the US online advertising market with Facebook in second with 21%, followed by software giant Microsoft and telecoms behemoth Verizon. While Amazon is thought to own just 4% of the market growth is outpacing that of its rivals, so much so that estimates suggest the company will overtake both Microsoft and Verizon by the end of 2018 to turn this two-play industry into a three-horse race.
Some analysts have suggested Amazon’s advertising business – currently the fastest growing segment after revenue more than doubled year-on-year in the third quarter to $2.2 billion – could become the main profit driver for Amazon, taking over the fast growing cloud-computing unit, as soon as 2021.
Amazon ad business flourishes as Google starts to see slowdown
At a time when Amazon’s ad business is growing at such a rate attention has turned to Google, which also released third quarter results revealing EPS of $13.06 per share compared to an expected $10.40. While delivering stronger margins (lower traffic costs with higher numbers of ad clicks) and benefiting from a number of one-off factors investors were similarly concerned about the slowdown in growth. Revenue was up 21% to $33.7 billion in the quarter, missing forecasts of $34 billion. Growth of 21% was two percentage points slower than expected and down from 24% a year earlier, while margins also tightened to 25% from 28% to limit the rise in operating profit to $8.3 billion from $7.7 billion.
Amazon’s ad business offers plenty of opportunity and risk
The key to dominance in online advertising comes down to data. Google and Facebook both gather unrivalled information that has drawn-in advertisers. On a global scale, the pair are thought to control anywhere between 60% to 80% of the online ad market.
When WPP, the largest advertising agency in the world, released its 2017 results earlier this year the focus was on the rise of digital ad spend on Google and Facebook. Now, Amazon is also on the list of threats. Martin Sorrell, who left the top job at WPP earlier this year to launch a new agency, said earlier this month that search is where the 'big, big war' will happen between Amazon and Google.
This is because Amazon, despite Google being the go-to site for practically any search on the Internet, is doing an extremely good job at cutting its rival out of the search process. The Economist reports that 56% of Americans that search for a product online begin that search directly on Amazon. Quite simply, the more people search on Amazon rather than Google, the more reason advertisers have to spend money on Amazon rather than Google. Amazon’s searches are, however, limited to products - a constraint that doesn’t apply to Google.
The potential of Amazon’s ad business is clearly there, and the company has proven countless times that it can successfully venture into new areas and carve out substantial market share rather quickly, but how it balances advertising with its other ambitions will prove vital. The concentration on products means those that offer services and retailers that don’t sell through the platform have little reason to advertise on Amazon. Plus, the company’s increasing amounts of own-branded products, spearheaded by its tablets and Alexa-powered smart speakers, could provide a conflict of interest as Amazon would have to find a delicate balance between maximising advertising revenue without harming its own products, and a way of prioritising its own products without ostracizing advertisers that offer competing products.
The eventual expansion of the ad business to capitalise on Amazon’s streaming services and smart speaker penetration will help broaden the appeal to advertisers in the future. Reports have surfaced that a free ad-supported tier of its Prime streaming service could be launched but the firm has since announced there is no immediate plans, and it was also rumoured earlier this year that Amazon was working with firms including Procter & Gamble about creating voice-ads. These prospects do, however, present another balancing act for Amazon to address as it will have to incorporate ads into its services without undermining those that subscribe through Prime.
Big advertising revenue means Amazon needs to use Big Data, and the more it uses the more regulators will place the company under the microscope. Amazon has so far largely managed to avoid the backlash that has hit others about how it uses and profits from data. The fallout from the Facebook-Cambridge Analytica scandal has opened a can of worms for the industry. While Amazon’s data-relationship with users is more commercial than that of the social media giant Amazon has not avoided scrutiny and is only likely to be thrown under the spotlight further as the ad business grows. Plus, the acquisition of Whole Foods has opened the door to information about our most common shopping habits (online and offline). The European Commission is currently looking into how Amazon uses data on third-party retailers – many of which fall into the awkward ‘partner-but-competitor’ area – to its advantage.
Amazon and Google infringe on one another’s territory
Amazon may be infringing on Google’s core advertising business but the search engine is also eyeing a push into the e-commerce company’s main market. E-commerce is seen as a promising vertical opportunity for Google, which has recently announced partnerships with retail giants Walmart and Target to allow their products to be bought using its Google Home devices. Alphabet chief executive Sundar Pichai has said there are 'huge opportunities' in e-commerce and he has even referred to the 'flywheel effects' that Amazon has been using for years to propel its growth. Alphabet’s ownership of YouTube means it also competes for advertising with Amazon’s streaming services.
Read more: Amazon Prime Day propels the flywheel
The aggressive competition to get smart speakers in our home is all about securing a window into as many consumer’s homes as possible before the competition does: not only do they provide a flood of rich data but they act as a direct shopping window in our homes. Amazon, for example, is thought to lose significant sums selling its Alexa devices because it’s all about getting them into as many homes as possible, not making money from selling them.
It is also worth noting Twitter’s recent improvement in the advertising space, up 29% in the third quarter to $593 million. Costs were down and engagement was up, while revenue from data licensing increased 25%.
Read more: Twitter’s Q3 results bear expectations
Amazon share price premium in doubt as sales begin to slow
While Amazon’s anticipated growth is nothing to be snuffed at – 15% yearly revenue growth is still astounding for a company of its size – the slowdown has cast doubt over the huge premium that Amazon boasts relative to other tech peers, trading at a price-to-earnings ratio of over 140x compared to Alphabet at 48x, Facebook at 23x and Apple at 20x.
This vast premium, which helped briefly make Amazon the second company after Apple to earn the illusive $1 trillion valuation following its Prime Day sale at the very start of the third quarter, has been based on the high rates of growth investors have become accustomed to and fuelled further by expectations for that rate of expansion to continue. The possibility that net sales could grow at just half the rate seen in the third quarter, therefore, has markets worried that growth has peaked and could start to decline.
Still, Amazon’s chief financial officer Brian Olsavsky said the company is still expecting a ‘strong holiday season’ and insisted there is ‘no message in our forward guidance’.
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